Renewables Industry Trends and Lessons From PVA
Introduction
As IPA sees more Low Carbon Energy (LCE) projects, we look to better understand the struggles that companies face when trying to implement them. Companies endeavor to tackle projects on the path of carbon reduction, but these projects often tend to be marginally economic at best—and heavy losses at worst. Reverse auctions squeeze project economics on renewable energy installations. Many carbon capture, utilization, and sequestration (CCUS) projects have to trade substantial carbon abatement with low costs, with only a select few projects achieving both. All of this then sits on the backdrop of ever-changing regulations that may add extra costs and lower the economic breakpoint. If companies are going to start tackling LCE projects sooner rather than later, handling the shaping is critical to project success. Therefore, IPA has taken a broader look into the non-technical shaping issues and business contexts of these projects. Through surveys and internal data, as well as in-person discussions with clients, we sought to ascertain where the industry stands when it comes to LCE context and provide insight to our clients. Building on Jon Walker’s Transitioning to New Energy: An IPA Energy Company Survey, we highlight some of the most striking trends we saw in our exploration.
Data: Both Qualitative and Quantitative
As part of our survey of 15 owner companies, we gathered information on LCE projects related to a company’s portfolio strategy, any external and internal barriers to project implementation experienced, their company’s gated process, and aspects of their early decision-making process. This survey laid the groundwork for further data gathering, because we could work to verify the survey results.
Secondly, we reviewed our database of LCE projects to find areas of struggle and success early in the Front-End Loading (FEL) stages. Our LCE dataset has more than 50 projects and includes several technologies: biofuels and biomass; CCUS; solar installations, both commercial and community; onshore and offshore wind; hydroelectric; and green hydrogen, both alkaline water and proton exchange membrane. We assessed the projects using our Project Viability Assessment (PVA) metrics. In basic terms, the PVA evaluates several factors—business basics, financial conditions, site factors, and scope framing—to rate the quality of a project’s business case as it stands after a Gate 1. The methodology is technologically agnostic because all questions surround the business case and the quality of FEL work completed up to that point.
Not only could we compare the various categories of technology—biofuels, CCUS, and renewables—but we could also compare the LCE sample to an industry sample: the model itself was built around a large dataset with a standard mix of oil and gas, chemicals, mining, and other sectors. In general, the PVA results for renewables were worse than the industry sample; however, CCUS projects were almost identical to overall industry performance, if not slightly lower, with renewables and biofuels each having equally poorer performances. (We describe the factors that lead to this lower performance later in this article.)
Finally, we held roundtables with owner organizations from our Industry Benchmarking Consortium (IBC) and Upstream Industry Benchmarking Consortium (UIBC) to get their specific insights into the state of LCE projects. These insights elaborated on the more general responses in the survey. The major insights from those discussions allowed us to further verify the survey results and make more conclusions based on our PVA sample’s results.
Areas of Struggle for Our Clients
We highlight five areas our clients’ LCE projects struggle with:
- Economics
- Basic Data
- Gated processes
- Permitting
- Personnel
Economics
The most important pain point from the survey was project economics, either in the form of an internal rate of return (IRR) or net present value (NPV). From our PVA data, only 25 percent of LCE projects modeled either an expected IRR or NPV by the first decision gate. This is striking against the 67 percent of companies in the overall PVA industry sample that modeled IRR or NPV. Companies we interviewed echoed this economics concern. Even worse, some companies in the roundtables stated their current IRR or NPV calculations are unreliable or overly optimistic due to a combination of too many assumptions and targets for the best case scenario only. It is a clear indication that the path forward is cloudy when such a common success metric either cannot be calculated or, when calculated, is considered likely inaccurate.
However, one thing that came up time and time again is the fact that economics was often not the main driver of these projects. For our clients, LCE projects stand as opportunities of strategic importance or rely on the availability of government stimulus to succeed. To be clear, our clients are still selecting projects based on profitability; the pattern we are describing merely shifts the focus away from maximizing profits to other, subjective elements. This leads to the question: If economics is not the main driver, why is it such a pain point? One answer lies in the gated process, which is discussed later. Briefly, economics is such a major focus in gated processes that it is still the focus even when it is not the main driver. We recognize that another component of economics is Basic Data, which we touch on later in this article. With that said, when the economics are the key input into the go/no-go decision, changing that standard to reflect the strategic value of LCE projects is still an important change for companies. Again, we are not saying economics and profitability are no longer a factor. Rather, some companies are acting on this concept and changing their gated processes to weigh other opportunity factors, such as business case clarity, equally or greater than economics.
Basic Data
As mentioned earlier, a key issue that affects the economics is Basic Data availability. In this case, Basic Data are any information needed to properly define the technical requirements and economics of a project. Some examples include the average wind speed at hub height for a wind farm, the solar radiance at a photovoltaic farm’s location in summer versus winter, or the price and harvest consistency of a feedstock such as soybeans or corn. For our clients, the phrase known unknowns came up many times in the IBC and UIBC discussions. How can a company define a good project without having the data necessary to do so?
We saw several interesting consequences of these Basic Data issues. One is closing scope. About 40 percent of LCE projects did not provide outside battery limits (OSBL) scope, and about 20 percent still had open inside battery limit (ISBL) scope, after the first decision gate. The other trends are related to the detail of a project’s economics. While 93 percent of LCE projects had cost estimates going into the scope development phase of Front-End Loading, only 63 percent were good quality—cost breakdowns that showed detail in major categories, such as construction labor, equipment, and bulk materials, not just high-level categorical summaries. We also saw a decreasing trend in companies’ first gate analyses: about two-thirds of the sample performed an economic analysis, while less than a third did a comprehensive market viability assessment. For comparison, in the PVA industry sample, 78 percent of projects performed an economic analysis while only about 70 percent both setting an acceptable price and completing a competitor analysis. However, LCE projects that performed a competitor analysis were likely to have performed the previous three analyses (if they reached acceptable price, they completed the first two analyses, etc.). Getting more in-depth with the analysis provided a better business case but that depends on the ability to get Basic Data.
Gated Processes
In the gated process, it is clear that inconsistency is rampant. Survey respondents and several IBC and UIBC companies said they had adopted a different gated process, as recently as 2022 in certain cases, and others are still developing a unique process. The remainder said they used the same gated process as other projects for LCE projects; however, these same processes were, as admitted by those companies, actually somewhat different, entirely ad-hoc, still in development, or just had their check gates effectively bypassed by upper management—this top-down push was echoed by IBC attendees. So, are the gated processes really the same in those situations? General consensus is that LCE projects need their own, dedicated gated process tailored to the technology. We recognize the value in this decision though still warn companies not to reject or expedite the gated process. (See Mitigating Risks of Early Commitment in New Energy Projects to understand how to handle the body of FEL work with an early commitment date.) Some IBC respondents that adapted newer gated processes still agreed that a gated process provided value to projects and, therefore, was vital despite its changes.
Beyond the first-hand accounts, what did the data say? Of LCE projects that had a Gate 1 (88 percent), nearly three‑quarters had what IPA would consider a strong Gate 1: a gate that is approving and interactive between the project team and management to ensure alignment. However, a concerning statistic challenges the strength of those gates: only 16 percent of LCE projects established clear exit criteria for their project at or after Gate 1 (compared to Industry’s 44 percent). While some projects established rough cost ceilings related to retail price at Gate 1 (about 30 percent of projects), explicit kill criteria—in the example of a cost ceiling, something like a true, hard-stop price—were not explored or reported. In addition, a majority of LCE projects in the database had unclear or vague business objectives; this aligned with companies listing business objectives as an internal struggle. These factors, combined with a lack of basic data, will lead to many weak projects passing Gate 1, which will result in an arduous process from business case approval through scope development and FID.
One last concern with gates is making sure the right people are at the table. Getting the right expertise, both on a business and technical level, is key to aligning on a business case and making the right decision on a project. As companies continue to reform their team formation and gated processes, we may start to see smoother workflows with more informed, complete pictures of the project scope.
Permitting
Another factor greatly restricting LCE project adoption is permitting concerns: rapid changes to policies and lack of knowledge from the governing bodies enforcing them make the process tenuous and lengthy. Many companies agreed on these external risks to projects. Our PVA data showed that 57 percent of LCE projects had identified and applied for their necessary permits early in FEL 2. In fact, about 27 percent of projects had their permits already in hand at that time. However, almost every interviewee at IBC and UIBC maligned the permitting process. The uncertainty, the irregularity, the involvement of third-parties—all these factors add up to a system that is difficult to navigate. Permitting is so lengthy, in fact, that some IBC respondents would rather pause a project than pause the permitting process for said project.
We expect there may be some bias in our data sample: projects that were able to begin the permitting process or to receive permits were more likely to move forward and seek an IPA risk evaluation than projects that were still being assessed. We would expect companies to apply for their permits around FEL 3 once scope selection and some definition work has occurred. This reality changes with early commitment projects, which may be required to have permits in hand before making a bid, often midway through FEL 2. Some IBC owner companies pointed out a troubling conundrum they face in these situations: in order to bid on a project, you need permits; in order to apply for permits, you need to provide a scope; in order to have a scope, you need to know the terms of the regulation or agreements; in order to know the terms of the agreement, you have to get the bid. With all this in mind, we encourage companies to enter discussions with regulatory bodies as early as possible. Building those connections with the regulatory bodies will be critical in working through this conundrum and allow both parties to agree on a particular solution. Though, again, this may be difficult when regulators themselves do not know what the rules are. IPA hopes to track major policy changes to help investing companies understand the regulatory landscape better.
Personnel
One last key struggle identified in our surveys, interviews, and data was staffing an LCE project team properly. There is a point of discussion whether to train internally or seek expertise externally, though the former requires balancing the demands of employees’ current work and the latter risks putting strain on potential contractors. Also, whether LCE projects get their own dedicated teams is still internally debated in several companies; some companies are making central LCE teams, while others are putting together teams of qualified employees ad-hoc. The IPA data support the many personnel concerns: only about 42 percent of renewables projects have key resource personnel identified. Related to this, as few as 26 percent of renewables projects provide clear roles and responsibilities documents. Both CCUS and biofuels projects saw better performance in both of these categories. However, across all LCE projects, only 20 percent identified and described the applicable project experience for each of the core team members. With how nascent some of these technologies are, finding and using talent is an area that continues to elude our clients. Through continued project data collection, we expect to be able to provide more applicable staffing and personnel guidance that builds on our current staffing understanding.
LCE Project Strengths
IPA notes the LCE database outperformed Industry in several ways. LCE projects had comparatively better risk management plans than the rest of Industry. This may be due to the uncertainties we mentioned previously, resulting in more in-depth analyses and numerous project mitigation strategies. LCE projects are also better at defining facility unit capacity than Industry—almost 100 percent of LCE projects do this versus Industry’s 75 percent. Lastly, while LCE projects included operations and maintenance on the project team less frequently than Industry (63 percent of the time versus 80 percent), they did identify the project’s operational needs more often (68 percent versus Industry’s 28 percent). In the LCE Industry, where projects are driven by getting the best levelized costs, both CAPEX and OPEX, these operational needs will be critical; the data show that companies recognize this importance by their operations analyses. However, there is a catch: trying to identify operational needs without proper Basic Data can lead to potentially significant missed scope (see Early Operations Integration Is Key to Meeting Production Targets in the Renewables Business). IPA seeks to collect OPEX data to better understand its contribution to business and project decisions.
Conclusions
Clearly, LCE projects face a lot of uncertainty—and therefore risk—both internally and externally. Governance processes, economics, permitting, Basic Data, and personnel are the biggest problem areas that need to be addressed. Some companies address these problems internally while others look for external aid. IPA continues to use our data and work with our clients to better target and address these vexations. We have developed tools like the PVA to help make the business case’s strengths and weaknesses clear. IPA is also developing other means of evaluating greater shaping issues: we are actively developing the Shaping and Viability Evaluation (SAVE) to directly gauge the various shaping and context issues of LCE projects. Combining the PVA analysis with SAVE will provide our clients a deeper analysis of how shaping manifests in the business case. With time, collaboration with our clients will continue to improve our capabilities and therefore better aid their needs to overcome these hurdles in the LCE space.